How likely is decade of 5% growth in U.S. economy?

In May, former Minnesota Gov. Tim Pawlenty declared his candidacy for the presidency of the United States. He also released a plan that is intended to lead to a revival of the U.S .economy, which is in the middle of an anemic recovery.

One of the key assumptions of this plan is that the economy can be coaxed and prodded into growing at an annual rate of 5 percent for a decade or more. As economist Donald Marron has pointed out, the U.S. economy has grown at an average rate of 5 percent for 10 years exactly once since the end of World War II.

That was the period from mid-1958 to mid-1968. As he puts it, "Getting up to 5 percent over the next decade thus seems not merely ambitious, but almost unthinkable."

However, Stanford macroeconomist, John B. Taylor, argues that 5 percent is quite doable. One percent growth per year can come from growth of the population. Taylor argues another one percent can come from having a greater percentage of the population employed as workers. The remaining growth needs to come from increases in the productivity of capital and workers – what economists call total factor productivity or TFP for short. Since 1996 TFP has grown at an average rate of 2.7 percent, so the remaining three percent needed is not that hard to imagine.

When discussing growth it is important to distinguish between two effects. The first is a levels effect.

This occurs when something happens to permanently raise or lower the long-run productive capacity of the economy. For example, a one-time increase in the population due to a baby boom, or a relaxation of immigration constraints would give us a larger workforce and increase the amount of goods and services we could produce.

Levels effects will cause the economy to grow in the short run as it adjusts slowly to incorporate these new resources. In the long run, however, the economy reaches a new higher level and then stays there without any further growth.

A second effect is a growth effect.

This is a change that does not necessarily change the productive capacity of the economy immediately, but rather causes it to grow more rapidly over time. An increase in the rate at which new knowledge is discovered and turned into useful products would cause the economy to grow more rapidly over time, and these increases would continue for a long time without gradually petering out as level effects must necessarily do.

Pawlenty's plan calls for reductions in tax rates, balancing the federal budget, easing government regulation and encouraging sound monetary policy. All of these are laudable goals, but they are also examples of levels effects.